Solving and Estimating Indeterminate DSGE Models
We propose a method for solving and estimating linear rational expectations models that exhibit indeterminacy and we provide step-by-step guidelines for implementing this method in the Matlab-based packages Dynare and Gensys. Our method redefines a subset of expectational errors as new fundamentals. This redefinition allows us to treat indeterminate models as determinate and to apply standard solution algorithms. We prove that our method is equivalent to the solution method proposed by Lubik and Schorfheide (2003, 2004), and using the New-Keynesian model described in Lubik and Schorfheide (2004), we demonstrate how to apply our theoretical results with a practical exercise.
We thank seminar participants at UCLA and at the Dynare workshop in Paris in July of 2010, where Farmer presented a preliminary draft of the solution technique discussed in this paper. That technique was further developed in Chapter 1 of Khramov’s Ph.D. thesis (Khramov, 2013). We would like to thank Thomas Lubik and three referees of this journal who provided comments that have considerably improved the final version. The ideas expressed herein do not reflect those of the Bank of England, the Monetary Policy Committee, the IMF, IMF policy, or the National Bureau of Economic Research.
Farmer, Roger E.A. & Khramov, Vadim & Nicolò, Giovanni, 2015. "Solving and estimating indeterminate DSGE models," Journal of Economic Dynamics and Control, Elsevier, vol. 54(C), pages 17-36. citation courtesy of